Even before the current crisis, the Fed was a powerful institution with few rivals for its Kremlin-like curtain of secrecy. Now, it seems fated to acquire even more sweeping powers, with only a few followers of Jeffersonian ideals in Congress seemingly interested or capable of questioning that move.
It is widely held that some public functions are so important that they must operate at arm’s-length from the influences of government and party politics. But, generally, the arm needs to be connected to a body that has its feet planted firmly on the ground. When it comes to the Federal Reserve Board, this anatomical connection is not entirely clear.
Exhibit A (as famed screenwriter Rod Serling used to say about scary things to come) is the apparent rejection by the Fed of a Treasury recommended review of the central bank’s structure and governance. These pages have been advocating that for well over a year, and long before it was proposed that the Fed take on even more sweeping powers.
Exhibit B is the news that the Fed will be given a lead role in overseeing pay packages at banks and in prohibiting compensation schemes that encourage inappropriate levels of risk. But the Fed wants the oversight to come in the form of the ultra opaque bank examination relationship it has with America’s financial institutions, which would effectively shield decisions from public scrutiny.
From its handling of the discount window and details about which banks and institutions are knocking on it to specifics about the Bear Stearns “collateral” it bought up, not to mention its role in the AIG bailout and the billions in payouts it approved to make good on credit default swaps with institutions like Goldman Sachs, the Fed is, and prefers to be, a creature of the shadows of cozy-club decision-making and not of the sunlight that affords transparent scrutiny. It operates in a world that hangs on its every word, yet that word is often issued by fiat, with little consideration shown to notions of public accountability. What banks and Wall Street want, however, is often a different matter. We know little about where the lives of Wall Street titans and Fed governors intersect. But if it is anything like what happens at the New York Fed, as we have noted before, where Wall Street titans are that institution’s governors, there is reason for Main Street to be worried.
As it has handled the crisis of the past year or so –the crisis it never saw coming– the Fed has taken interest rates to zero (for banks; not consumers, where credit card rates are proportionally higher than at any time in human history), smashed open the dams of liquidity, and created a Fed cash-for-clunkers program for broken-down financial assets that has no precedent in the annals of economic thought. In doing so, it has created an artificial market from which Wall Street is the most significant beneficiary, even though it was the principal source of the problems. Its moves to provide everything Wall Street wanted have permitted bonuses and huge pay days to be resumed, with barely an interruption. Outside Wall Street, job losses continue to mount and Main Street still awaits the arrival of the famous Fed-promised trickle-down economy.
Yet for all its power and soon-to-be-added authority, it is by no means clear that the Fed possesses any better vision to see another coming storm down the road, especially one of its own concoction from a combination of zero-interest, swirling liquidity, monetized debt and a floundering U.S. dollar. It is debatable whether it possesses the moral clarity, either. The fact that it was in the room and permitted the outrageous compensation decisions at AIG, and allowed billions to be passed on to other institutions in what could not be a more classic redistribution of wealth had it originated from Moscow in the 1950s, gives reason to doubt the Fed’s capacity to act in any role whatever when it comes to deciding compensation issues.
Even before the current crisis, the Fed was a powerful institution with few rivals for its Kremlin-like curtain of secrecy that cannot be questioned. With the Administration’s package of sweeping financial reforms, the Fed is taking on the trappings, along with the arrogance and the influence, of a fourth branch of government, with only a few followers of Jeffersonian ideals in Congress seemingly interested or capable of questioning that move. This is an institution, like the very bodies it regulates, where the culture needs to change dramatically; governance reforms are an important step in achieving that goal.
We think it would be a most unwise turn in public policy to seek to solve one problem, namely the risk-oblivious and compensation-obsessed Wall Street that produced the worst economic crisis since the 1930s, by creating a transparency- oblivious, secrecy-obsessed Fed with more power to shape the world as it sees it. Its sights, as we have observed before and from these recent examples, rarely extend beyond a few blocks in lower Manhattan.